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Three reasons an investment in Myer could double

When you mention department store chain Myer (ASX: MYR) and its super cheap stock, most investors will simply say that it is a “classic value trap.”

At least that’s what I keep hearing. However, a bit of digging reveals a more nuanced picture. Sure, Myer shares have significantly underperformed the S&P/ASX 200 index (Index: ^AXJO) (ASX: XJO) since the 2009 listing. But the future may be much brighter.

Here are three reasons why the Myer bears may be wrong – and why an investment in Myer could plausibly double within five years.

Reason #1: Good management

With his political comments, Myer CEO Bernie Brookes can be hard to like, but that doesn’t mean he isn’t a savvy, deeply invested leader. Importantly, Brookes owns 1.7% of Myer stock, or about $25 million worth. This means a significant portion of his personal wealth is tied up in Myer stock and that preserving the dividend will be important to him.

With his deep experience in retailing, including years at Woolworths (ASX: WOW), Brookes seems to know how to attract and satisfy Myer’s core customers. As evidence, in 2012, “Myer was proud to be named the Department Store of the Year in the Roy Morgan Customer Satisfaction Awards… The result of the poll of over 50,000 customers is an endorsement of our improving performance in relation to customer service and a great reflection on the quality of all our team members’ efforts.” He and his team have also rightly put emphasis on Myer exclusive brands and the loyalty program — more of which below.

Reason #2: The business is getting stronger, not weaker

It’s true. There’s an argument to be made that Myer’s business is getting stronger, not weaker. Myer sales are growing now, albeit in a small way, rising 1.7% for the half year. Through the company’s robust, well run rewards program, management is moving to solidify the company’s relationship with its most loyal customers. (It’s a move few department store retailers seem capable of, both in Australia and elsewhere.) Some 70% of sales come from customers enrolled in the loyalty program.

Meanwhile, the company is also exiting lower margin categories and focusing on exciting brands in store. For instance, in 2012, “Sales in Myer Exclusive Brands grew by 10.0 percent to $343 million and now represent almost 20 percent of sales, driven by strong customer support.”

In part because of these initiatives, gross profit margins have grown five percentage points since 2007, and Myer enjoys significantly higher gross margins than competitor David Jones (ASX: DJS) — which, frankly, should embarrass David Jones’ management.

With these signs in mind, and the fact that Myer’s store network isn’t overbuilt – some 68 stores in prime locations — and online sales have been growing at a great clip from a small base, the future does not look grim.

Reason #3: Valuation, dividend and a possible double

Today, Myer shares are trading for about 8 times free cash, 10 times earnings, and on an EV to EBITDA basis of less than 6. Given the cheap valuation today, this positions the company to perform well in the years to come.

Could an investment in Myer double over the next five years? When you consider that the dividend alone, grossed up to include franking benefits, will give returns of 10%, and then you add in just the market’s average annual return of 8%, such a scenario begins to look plausible, even likely.

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Motley Fool contributor Catherine Baab-Muguira does not own shares of any company mentioned in this article.

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